A nudge in the right direction

30th November 2017

Elisabeth Jeffries looks at the Task Force on Climate-related Financial Disclosures, which aims to redirect companies away from high-emitting fuels and encourage more strategic reporting

Had German utility RWE reconsidered political risk, its finances in 2015-2017 might have been stronger. The company’s shares fell in September 2017, after news that Germany’s Green Party could join a government coalition. Earlier in the year, and partly for the same reason, its profits declined and the company scrapped its dividend.

That, at least, is the view of non-profit carbon disclosure organisation the CDP. The utility should open up more about the physical and regulatory climate-related risks to its business, the organisation suggests. Like many carbon-intensive firms, RWE has had to grapple with new cleantech policies, a risk that could hurt the firm. “RWE continues to struggle with the Energiewende, Germany’s energy market transformation,” observes Luke Fletcher, CDP utility analyst.

But now around 100 major businesses backed by CDP and other non-profits are uniting to exert more pressure, not just on utilities such as RWE but on hydrocarbons, industrial and service companies. The consortium, known as the Task Force on Climate-related Financial Disclosures (TCFD) and launched in July 2017, wants more transparency on transitional and physical climate-related risk and opportunity in annual reports. Founded by global governance organisation the Financial Stability Board, TCFD claims many corporations still ignore this risk.

Reporting in this way means classifying assets, liabilities and acquisitions under the lens of climate change, facilitating a more appropriate pricing of risks and capital allocation. This could pre-empt regulation, and shifts the corporate perspective beyond immediate concerns.

A voluntary initiative, TCFD is influenced by shareholder activists, of course. Businesses with major fossil fuel assets may well be reluctant to report down a channel with the potential to undermine their core business. Yet TCFD’s demands are not particularly radical, since – in the UK at least – the Companies Act 2006 already requires corporations to describe the principal risks and uncertainties they face in their strategic reports. Nevertheless, many have omitted climate.

Improvements have been visible since the past decade as organisations responded to either regulatory or shareholder demands for data on historic greenhouse gas emissions. But now the pressure imposed by TCFD is to disclose consistently, not just in the corporate responsibility report but in financial filings – and to examine the future as well as the past.

TCFD suggestions do not require innovative accounting but in-depth information. “It would change what the directors are telling us in the strategic report, but wouldn’t change the balance sheet and profit and loss account,” explains Russell Picot, special adviser to TCFD and former chief accounting officer at HSBC.

“Including climate risk would sharpen disclosures on the impairment of cashflows arising from assets,” he says. In addition, investors would access comparable scenario analysis relating at least to a 2°C temperature increase scenario as well as, for instance, business-as-usual (greater than 2°C) scenarios.

Some TCFD recommendations have already been met, but this is still rare. In its 2017 annual report, Scottish utility SSE provides considerable detail, scoring high marks from CDP. The company considers risks and opportunities arising from climate change in addition to a longer discussion in its sustainability report.

Unusually, it models its resilience against three core future energy scenarios, where Great Britain contributes a share of carbon reduction to limit global temperature rises to 2°C, 1.5°C and business as usual – between 3°C and 4°C. The analysis showed likely events if each scenario played out, and how SSE would respond.

Norwegian company Statoil is the best oil and gas performer on carbon disclosure for the longer-term horizon, according to CDP. In its 2016 annual report, Statoil states that the International Energy Agency’s aim of limiting greenhouse gases in the atmosphere to around 450 parts per million of CO2 “could have a positive impact of approximately 6% on Statoil’s net present value compared to Statoil’s internal planning assumptions as of December 2016”.

Meanwhile, reporting on the basis of carbon prices is improving, although it is highly inconsistent. Carbon pricing can be perceived as another way to express the risk of regulation on carbon emissions and to test corporate resilience in that light. Eight out of 11 oil and gas majors considered by the CDP use an internal carbon price, which ranges from US$22/tonne to US$57/tonne. Three are silent on the matter.

Among energy utilities, CDP finds RWE’s profitability most exposed to carbon pricing, so that its carbon costs reduce its earnings before interest and tax by 13.7%, assuming a 2015 average traded carbon market price of €7.70. By contrast, the comparable figure for some other utilities, such as Centrica and Iberdrola, is less than 1%.

RWE is often criticised. But it does address some of these issues in its reporting, discussing the risk to its business from climate policy in the chief executive section of its 2016 annual report, for instance. However, CDP indicates that it publishes less than rivals.

The actual frameworks of climate risk disclosure have yet to be shaped. “We need to see a period of experimentation. Three or four years down the road, we could potentially be assessing what is useful in the voluntary disclosures, and see it codified by institutions through, for example, stock exchange guidelines,” says Picot.

He suggests that the most significant progression would be found in strategic discussions. “This is not going to result in a huge data drop by companies, but rather a thoughtful narrative description from board directors. It will hopefully be used as an engagement tool as well as a divestment tool,” he says. A move towards less carbon-intensive business models could result, as well as a speedier transition to a low-carbon economy. However, says Picot: “We’re not saying they should alter their business model but that the information needs to get out there so that the market can decide.”

Disclosures on climate-related risk are improving, especially in the heavily regulated utility sector. However, this highly politicised argument will not be won overnight. Private-sector carbon-intensive corporations may agree to improve the quality of disclosure on climate change risks or physical resilience. In doing so, they are not just passively warding off risks – they are still powerful enough to influence the effects of disclosure.

Elisabeth Jeffries is a journalist and director of Spotted Lynx Media

Image credit: shutterstock


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